As the European-led ESG movement gained traction in the U.S., inflows into ESG-related funds have soared, and more companies are implementing ESG strategies and reporting on metrics. However, in order to drive real value, there is a need for a new paradigm, one in which ESG is not just for the benefit of the company, but is embedded in goals, strategies and operations, according to George Serafeim, Charles M. Williams Professor of Business Administration and the Chair of the Impact-Weighted Accounts Project at Harvard Business School.
“We have witnessed an incredible amount of growth in economic activity as it relates to ESG issues. That is a reflection of the increasing importance of these issues and how important they have become for profitability, valuation and cost structures across many industries,” Serafeim said during his keynote address at Nasdaq’s Virtual ESG Summit 2020.
In his studies, Serafeim has examined thousands of companies, analyzing their operating performance, as well as ESG performance. For many companies, however, reporting tends to drive strategy, as opposed to strategy driving reporting, and those companies often don’t experience the benefits. Serafeim recommends that companies focus on five key areas to develop and execute an ESG strategy that drives real value.
1. Think Strategy
Historically, there has been quite a bit of variation among ESG strategies, but over time, that variation diminished. In many cases, industry peers have adopted similar ESG strategies, which are often thought of as a compliance exercise, relating to risk management and operational efficiency.
“But this is quite distinct from what strategy is,” Serafeim said. “Strategy is doing everything different compared to what your competitors do and having a different ESG strategy that relates to your unique competitive position.”
During his studies, Serafeim has found that companies that differentiated their ESG strategy became more efficient and effective, while also becoming more profitable relative to the amount of capital being deployed and enjoying better operating margins.
They develop such a competitive edge that for many competitors it is hard to [catch] up because those innovations take time, and this is the importance of not actually thinking about ESG only as operational effectiveness, but also thinking about it in terms of strategy.
Professor, Harvard Business School
2. Boards Should Take the Lead
The companies that have implemented an ESG strategy that creates real value, “in almost all cases, the board has been actively involved – and it has been quite pronounced on both the audit committee and compensation committee,” Serafeim noted. With boards increasingly evaluating ESG metrics, the quality and robustness of the data elevated, which signifies that these are strategic efforts guiding the resources within the business.
Even with increased attention and commitment to ESG at the highest levels of a company, Serafeim said that those efforts must be embraced throughout all levels of the company. Otherwise, those efforts may be sidelined and not consistently implemented.
3. Corporate Purpose Should be Culture
Purpose and culture may be thought of as separate aspects within a corporate setting, but that would be a mistake, according to Serafeim.
“Purpose is about the culture of the organization and how people behave, what are the norms, beliefs and systems to which their organization behaves,” he said.
Serafeim emphasized the importance of embedding purpose into the culture so that every employee feels the same sense of commitment. Then, “purpose can lead to stronger performance, stronger valuation and stronger growth of corporate profits,” Serafeim said.
4. Embedding ESG to Optimize New Markets, New Growth & New Innovation
Serafeim’s studies have also revealed that the most successful companies “have been able to decentralize the responsibility around ESG efforts.”
By decentralizing ESG activities to go beyond the sustainability department, “those responsibilities then become part of the procurement process, the marketing process and the product design process,” he noted.
“Then [a company] can start finding those opportunities for new markets, new growth and new innovation,” Serafeim said.
5. Advanced ESG Programs Evolving from Intentions to Impact Transparency
As more companies work to implement an ESG strategy, Serafeim noted that the conversation is changing from the effort and willingness of companies to incorporate it, and “moving toward measuring and systemically understanding outcomes and impacts from those efforts.”
For example, if a company has adopted a policy to reduce its carbon footprint, it should go beyond the path to de-carbonization to include the products and offerings that help improve the supply chain.
Serafeim’s valuable insights on ESG strategies kicked off a series of breakout sessions, from analyzing trends in investor ESG interests and the impact of transitioning to a low-carbon economy to examining the green space in the muni market and how financial advisors are using ESG.
Find replays of each session at the link below.